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Saturday, May 21, 2016

If
a company reports earnings of $1 billion, does this mean it has this amount of
cash in the bank? Not necessarily. Financial statements are based on accrual
accounting, which takes into account non-cash items. It does this in an effort
to best reflect the financial health of a company. However, accrual accounting
may create accounting noise, which sometimes needs to be tuned out so that it's
clear how much actual cash a company is generating. The statement of cash flow
provides this information, and here we look at what cash flow is and how to
read the cash flow statement.

What
Is Cash Flow?

Business is all about trade, the exchange of value between two or more parties,
and cash is the asset needed for participation in the economic system. For this
reason - while some industries are more cash intensive than others - no
business can survive in the long run without generating positive cash flow per
share for its shareholders. To have a positive cash flow, the company's
long-term cash inflows need to exceed its long-term cash outflows.

An
outflow of cash occurs when a company transfers funds to another party (either
physically or electronically). Such a transfer could be made to pay for
employees, suppliers and creditors, or to purchase long-term assets and
investments, or even pay for legal expenses and lawsuit settlements. It is
important to note that legal transfers of value through debt - a purchase made
on credit - is not recorded as a cash outflow until the money actually leaves
the company's hands.

A
cash inflow is of course the exact opposite; it is any transfer of money that
comes into the company's possession. Typically, the majority of a company's
cash inflows are from customers, lenders (such as banks or bondholders) and
investors who purchase company equity from the company. Occasionally cash flows
come from sources like legal settlements or the sale of company real estate or
equipment.

Cash
Flow vs Income

It is important to note the distinction between being profitable and having
positive cash flow transactions: just because a company is bringing in cash
does not mean it is making a profit (and vice versa).

For
example, say a manufacturing company is experiencing low product demand and
therefore decides to sell off half its factory equipment at liquidation prices.
It will receive cash from the buyer for the used equipment, but the
manufacturing company is definitely losing money on the sale: it would prefer
to use the equipment to manufacture products and earn an operating profit. But
since it cannot, the next best option is to sell off the equipment at prices
much lower than the company paid for it. In the year that it sold the
equipment, the company would end up with a strong positive cash flow, but its
current and future earnings potential would be fairly bleak. Because cash flow
can be positive while profitability is negative, investors should analyze income
statements as well as cash flow statements, not just one or the other.

What
Is the Cash Flow Statement?
There are three important parts of a company's financial statements: the
balance sheet, the income statement and the cash flow statement. The balance
sheet gives a one-time snapshot of a company's assets and liabilities . And the
income statement indicates the business's profitability during a certain
period.

The
cash flow statement differs from these other financial statements because it
acts as a kind of corporate checkbook that reconciles the other two statements.
Simply put, the cash flow statement records the company's cash transactions
(the inflows and outflows) during the given period. It shows whether all those
lovely revenues booked on the income statement have actually been collected. At
the same time, however, remember that the cash flow does not necessarily show
all the company's expenses: not all expenses the company accrues have to be
paid right away. So even though the company may have incurred liabilities it
must eventually pay, expenses are not recorded as a cash outflow until they are
paid (see the section "What Cash Flow Doesn't Tell Us" below).

The
following is a list of the various areas of the cash flow statement and what
they mean:

Cash flow from
operating activities - This section measures the
cash used or provided by a company's normal operations. It shows the
company's ability to generate consistently positive cash flow from
operations. Think of "normal operations" as the core business
of the company. For example, Microsoft's normal operating activity is
selling software.

Cash flows
from investing activities - This area lists all the cash
used or provided by the purchase and sale of income-producing assets. If
Microsoft, again our example, bought or sold companies for a profit or
loss, the resulting figures would be included in this section of the
cash flow statement.

Cash flows
from financing activities- This section
measures the flow of cash between a firm and its owners and creditors.
Negative numbers can mean the company is servicing debt but can also
mean the company is making dividend payments and stock repurchases,
which investors might be glad to see.

When
you look at a cash flow statement, the first thing you should look at is the
bottom line item that says something like "net increase/decrease in cash
and cash equivalents", since this line reports the overall change in the
company's cash and its equivalents (the assets that can be immediately
converted into cash) over the last period. If you check under current assets on
the balance sheet, you will find cash and cash equivalents (CCE or CC&E).
If you take the difference between the current CCE and last year's or last
quarter's, you'll get this same number found at the bottom of the statement of
cash flows.

In
the sample Microsoft annual cash flow statement (from June 2004) shown below,
we can see that the company ended up with about $9.5 billion more cash at the
end of its 2003/04 fiscal year than it had at the beginning of that fiscal year
(see "Net Change in Cash and Equivalents"). Digging a little deeper,
we see that the company had a negative cash outflow of $2.7 billion from
investment activities during the year (see "Net Cash from Investing
Activities"); this is likely from the purchase of long-term investments,
which have the potential to generate a profit in the future.Generally, a
negative cash flow from investing activities are difficult to judge as either
good or bad - these cash outflows are investments in future operations of the
company (or another company); the outcome plays out over the long term.

The
"Net Cash from Operating Activities" reveals that Microsoft generated
$14.6 billion in positive cash flow from its usual business operations - a good
sign. Notice the company has had similar levels of positive operating cash flow
for several years. If this number were to increase or decrease significantly in
the upcoming year, it would be a signal of some underlying change in the
company's ability to generate cash.

Digging
Deeper into Cash Flow

All companies provide cash flow statements as part of their financial
statements, but cash flow (net change in cash and equivalents) can also be
calculated as net income plus depreciation and other non-cash items.

Generally,
a company's principal industry of operation determine what is considered proper
cash flow levels; comparing a company's cash flow against its industry peers is
a good way to gauge the health of its cash flow situation. A company not
generating the same amount of cash as competitors is bound to lose out when
times get rough.

Even
a company that is shown to be profitable according to accounting standards can
go under if there isn't enough cash on hand to pay bills. Comparing amount of
cash generated to outstanding debt, known as the operating cash flow ratio,
illustrates the company's ability to service its loans and interest payments.
If a slight drop in a company's quarterly cash flow would jeopardize its loan
payments, that company carries more risk than a company with stronger cash flow
levels.

Unlike
reported earnings, cash flow allows little room for manipulation. Every company
filing reports with the Securities and Exchange Commission (SEC) is required to
include a cash flow statement with its quarterly and annual reports. Unless
tainted by outright fraud, this statement tells the whole story of cash flow:
either the company has cash or it doesn't.
What Cash Flow Doesn't Tell Us
Cash is one of the major lubricants of business activity, but there are certain
things that cash flow doesn't shed light on. For example, as we explained
above, it doesn't tell us the profit earned or lost during a particular period:
profitability is composed also of things that are not cash based. This is true
even for numbers on the cash flow statement like "cash increase from sales
minus expenses", which may sound like they are indication of profit but
are not.

As
it doesn't tell the whole profitability story, cash flow doesn't do a very good
job of indicating the overall financial well-being of the company. Sure, the
statement of cash flow indicates what the company is doing with its cash and
where cash is being generated, but these do not reflect the company's entire
financial condition. The cash flow statement does not account for liabilities
and assets, which are recorded on the balance sheet. Furthermore accounts
receivable and accounts payable, each of which can be very large for a company,
are also not reflected in the cash flow statement.

In
other words, the cash flow statement is a compressed version of the company's
checkbook that includes a few other items that affect cash, like the financing
section, which shows how much the company spent or collected from the
repurchase or sale of stock, the amount of issuance or retirement of debt and
the amount the company paid out in dividends.

The
Bottom Line
Like so much in the world of finance, the cash flow statement is not
straightforward. You must understand the extent to which a company relies on
the capital markets and the extent to which it relies on the cash it has itself
generated. No matter how profitable a company may be, if it doesn't have the
cash to pay its bills, it will be in serious trouble.

At
the same time, while investing in a company that shows positive cash flow is
desirable, there are also opportunities in companies that aren't yet cash-flow
positive. The cash flow statement is simply a piece of the puzzle. So,
analyzing it together with the other statements can give you a more overall look
at a company' financial health. Remain diligent in your analysis of a company's
cash flow statement and you will be well on your way to removing the risk of
one of your stocks falling victim to a cash flow crunch.

Sir do you recommend any chemical or pharma stocks in current ongoing crude debacle.everywhere thought process going on about low crude prices to benefit chemical industry from India so anything in this space which you see will be good to buy and hold.

Sir,how do you perceive the Samkrg Pistons results? They apparently have a sudden increase in employee costs which is probably the single most reason for the decline in profits.Kindly share your views.

There was a labor unrest in company's plant in recent past and the increase in labor cost may be part of settlement.I am reasonably positive on auto ancillary space and on a full year basis Samkrg is trading at a P/E of less than 10 which is not too much expensive.

In SAMKRG results there is huge increase in Employee benefits expenses & Stores and spares consumption. Do you have any idea. Considering the annual EPS I think the stock is currently undervalued. Please share your valuable opinion Thanks in Advance

For the full fiscal ended March 2016, on a consolidated basis company posted a net profit after taxes, minority interest and share of profit/loss of associates of Rs.431.49 crore, where it was a loss of Rs.57.76 crore during the previous fiscal.

Is it good to hold VRL Logistics after recent results and announcement of the main owners decision to sell and shift some capital into aviation Industry with no consent or discussion with shareholders? You opinion and view to hold or sell or buy would be highly appreciated,

Hello Sir, In the interest of readers below is the update on your favorite pick from microfinance sector....http://economictimes.indiatimes.com/industry/banking/finance/satin-creditcare-to-stay-in-cradle-for-2-more-years-before-evolving-into-an-universal-bank/articleshow/52384966.cms

Sir everywhere i am seeing its written that Subex reports fivefold rise in profit at Rs 58.7 crore for the financial year ending March 31, 2016 but for March 2016 its showing a loss of Rs.208 crore and for the full year around RS.131 loss so i am not getting how come a profit of Rs.58.7 crore can you please explain to me sir.